filings.toolsItem 8. Financial Statements and Supplementary Data
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Item 8. Financial Statements and Supplementary Data
INDEX
TRACTOR SUPPLY COMPANY
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) under the Securities Exchange Act of 1934, as amended). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 29, 2018. In making this assessment, management used the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Based on this assessment, management believes that, as of December 29, 2018, the Company’s internal control over financial reporting is effective based on those criteria.
Ernst & Young LLP, the independent registered public accounting firm which also audited the Company’s Consolidated Financial Statements, has issued a report on the Company’s internal control over financial reporting, which is included herein.
| /s/ Gregory A. Sandfort | /s/ Kurt D. Barton | |||
| Gregory A. Sandfort Chief Executive Officer | Kurt D. Barton Executive Vice President - Chief Financial Officer and Treasurer | |||
| February 21, 2019 | February 21, 2019 |
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Tractor Supply Company
Opinion on the Internal Control Over Financial Reporting
We have audited Tractor Supply Company’s internal control over financial reporting as of December 29, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Tractor Supply Company (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 29, 2018, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Consolidated Balance Sheets of Tractor Supply Company as of December 29, 2018 and December 30, 2017,and the related Consolidated Statements of Income, Comprehensive Income, Stockholders’ Equity, and Cash Flows for each of the three fiscal years in the period ended December 29, 2018, and the related notes and our report dated February 21, 2019, expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
Nashville, Tennessee
February 21, 2019
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Tractor Supply Company
Opinion on the Financial Statements
We have audited the accompanying Consolidated Balance Sheets of Tractor Supply Company (the Company) as of December 29, 2018 and December 30, 2017, the related Consolidated Statements of Income, Comprehensive Income, Stockholders' Equity, and Cash Flows for each of the three fiscal years in the period ended December 29, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the Consolidated Financial Statements present fairly, in all material respects, the financial position of the Company at December 29, 2018 and December 30, 2017, and the results of its operations and its cash flows for each of the three fiscal years in the period ended December 29, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 29, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 21, 2019, expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2001.
Nashville, Tennessee
February 21, 2019
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
| Fiscal Year | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| (52 weeks) | (52 weeks) | (53 weeks) | |||||||||
| Net sales | $ | 7,911,046 | $ | 7,256,382 | $ | 6,779,579 | |||||
| Cost of merchandise sold | 5,208,518 | 4,764,417 | 4,454,377 | ||||||||
| Gross profit | 2,702,528 | 2,491,965 | 2,325,202 | ||||||||
| Selling, general and administrative expenses | 1,823,440 | 1,639,749 | 1,488,164 | ||||||||
| Depreciation and amortization | 177,351 | 165,834 | 142,958 | ||||||||
| Operating income | 701,737 | 686,382 | 694,080 | ||||||||
| Interest expense, net | 18,352 | 13,859 | 5,810 | ||||||||
| Income before income taxes | 683,385 | 672,523 | 688,270 | ||||||||
| Income tax expense | 151,028 | 249,924 | 251,150 | ||||||||
| Net income | $ | 532,357 | $ | 422,599 | $ | 437,120 | |||||
| Net income per share – basic | $ | 4.34 | $ | 3.31 | $ | 3.29 | |||||
| Net income per share – diluted | $ | 4.31 | $ | 3.30 | $ | 3.27 | |||||
| Weighted average shares outstanding | |||||||||||
| Basic | 122,651 | 127,588 | 132,905 | ||||||||
| Diluted | 123,471 | 128,204 | 133,813 | ||||||||
| Dividends declared per common share outstanding | $ | 1.20 | $ | 1.05 | $ | 0.92 |
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
| Fiscal Year | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| (52 weeks) | (52 weeks) | (53 weeks) | |||||||||
| Net income | $ | 532,357 | $ | 422,599 | $ | 437,120 | |||||
| Other comprehensive income: | |||||||||||
| Change in fair value of interest rate swaps, net of taxes | 456 | 1,371 | 1,392 | ||||||||
| Reclassification of stranded tax effects (ASU 2018-02) | — | 595 | — | ||||||||
| Total other comprehensive income | 456 | 1,966 | 1,392 | ||||||||
| Total comprehensive income | $ | 532,813 | $ | 424,565 | $ | 438,512 |
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
| December 29, 2018 | December 30, 2017 | ||||||
| ASSETS | |||||||
| Current assets: | |||||||
| Cash and cash equivalents | $ | 86,299 | $ | 109,148 | |||
| Inventories | 1,589,542 | 1,453,208 | |||||
| Prepaid expenses and other current assets | 114,447 | 88,252 | |||||
| Income taxes receivable | 4,111 | 4,760 | |||||
| Total current assets | 1,794,399 | 1,655,368 | |||||
| Property and equipment: | |||||||
| Land | 100,767 | 99,336 | |||||
| Buildings and improvements | 1,110,767 | 1,037,730 | |||||
| Furniture, fixtures and equipment | 645,702 | 605,957 | |||||
| Computer software and hardware | 349,500 | 266,898 | |||||
| Construction in progress | 130,812 | 83,816 | |||||
| Property and equipment, gross | 2,337,548 | 2,093,737 | |||||
| Accumulated depreciation and amortization | (1,203,084 | ) | (1,049,234 | ) | |||
| Property and equipment, net | 1,134,464 | 1,044,503 | |||||
| Goodwill and other intangible assets | 124,492 | 124,492 | |||||
| Deferred income taxes | 6,607 | 18,494 | |||||
| Other assets | 25,300 | 25,912 | |||||
| Total assets | $ | 3,085,262 | $ | 2,868,769 | |||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
| Current liabilities: | |||||||
| Accounts payable | $ | 619,981 | $ | 576,568 | |||
| Accrued employee compensation | 54,046 | 31,673 | |||||
| Other accrued expenses | 232,416 | 201,656 | |||||
| Current portion of long-term debt | 26,250 | 25,000 | |||||
| Current portion of capital lease obligations | 3,646 | 3,545 | |||||
| Income taxes payable | 1,768 | 10,772 | |||||
| Total current liabilities | 938,107 | 849,214 | |||||
| Long-term debt | 381,100 | 401,069 | |||||
| Capital lease obligations, less current maturities | 29,270 | 32,617 | |||||
| Deferred rent | 107,038 | 105,906 | |||||
| Other long-term liabilities | 67,927 | 61,290 | |||||
| Total liabilities | 1,523,442 | 1,450,096 | |||||
| Stockholders’ equity: | |||||||
| Preferred Stock, $1.00 par value; 40 shares authorized; no shares issued | — | — | |||||
| Common Stock, $0.008 par value; 400,000 shares authorized at December 29, 2018 and December 30, 2017; 171,887 shares issued and 121,828 shares outstanding at December 29, 2018 and 170,375 shares issued and 125,303 shares outstanding at December 30, 2017 | 1,375 | 1,363 | |||||
| Additional paid-in capital | 823,413 | 716,228 | |||||
| Treasury Stock, at cost, 50,059 shares at December 29, 2018 and 45,072 shares at December 30, 2017 | (2,480,677 | ) | (2,130,901 | ) | |||
| Accumulated other comprehensive income | 3,814 | 3,358 | |||||
| Retained earnings | 3,213,895 | 2,828,625 | |||||
| Total stockholders’ equity | 1,561,820 | 1,418,673 | |||||
| Total liabilities and stockholders’ equity | $ | 3,085,262 | $ | 2,868,769 |
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
| Common Stock | Additional Paid-in Capital | Treasury Stock | Accum. Other Comp. Income | Retained Earnings | Total Stockholders’ Equity | |||||||||||||||||||||
| Shares | Dollars | |||||||||||||||||||||||||
| Stockholders' equity at December 26, 2015 | 134,224 | $ | 1,352 | $ | 596,131 | $ | (1,429,790 | ) | $ | — | $ | 2,225,601 | $ | 1,393,294 | ||||||||||||
| Issuance of common stock under employee stock purchase plan | 70 | 1 | 4,808 | 4,809 | ||||||||||||||||||||||
| Exercise of stock options and restricted stock units | 899 | 7 | 36,194 | 36,201 | ||||||||||||||||||||||
| Share-based compensation | 23,554 | 23,554 | ||||||||||||||||||||||||
| Tax benefit of stock options exercised | 11,671 | 11,671 | ||||||||||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (843 | ) | (843 | ) | ||||||||||||||||||||||
| Repurchase of common stock | (4,398 | ) | (331,708 | ) | (331,708 | ) | ||||||||||||||||||||
| Dividends paid | (122,272 | ) | (122,272 | ) | ||||||||||||||||||||||
| Change in fair value of interest rate swaps, net of taxes | 1,392 | 1,392 | ||||||||||||||||||||||||
| Net income | 437,120 | 437,120 | ||||||||||||||||||||||||
| Stockholders' equity at December 31, 2016 | 130,795 | 1,360 | 671,515 | (1,761,498 | ) | 1,392 | 2,540,449 | 1,453,218 | ||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | 83 | 1 | 4,282 | 4,283 | ||||||||||||||||||||||
| Exercise of stock options and restricted stock units | 349 | 2 | 12,045 | 12,047 | ||||||||||||||||||||||
| Share-based compensation | 29,202 | 29,202 | ||||||||||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (816 | ) | (816 | ) | ||||||||||||||||||||||
| Repurchase of common stock | (5,924 | ) | (369,403 | ) | (369,403 | ) | ||||||||||||||||||||
| Dividends paid | (133,828 | ) | (133,828 | ) | ||||||||||||||||||||||
| Change in fair value of interest rate swaps, net of taxes | 1,371 | 1,371 | ||||||||||||||||||||||||
| Net income | 422,599 | 422,599 | ||||||||||||||||||||||||
| Reclassification of stranded tax effects (ASU 2018-02) | 595 | (595 | ) | — | ||||||||||||||||||||||
| Stockholders' equity at December 30, 2017 | 125,303 | 1,363 | 716,228 | (2,130,901 | ) | 3,358 | 2,828,625 | 1,418,673 | ||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | 78 | 1 | 4,359 | 4,360 | ||||||||||||||||||||||
| Exercise of stock options and restricted stock units | 1,434 | 11 | 75,272 | 75,283 | ||||||||||||||||||||||
| Share-based compensation | 28,921 | 28,921 | ||||||||||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (1,367 | ) | (1,367 | ) | ||||||||||||||||||||||
| Repurchase of common stock | (4,987 | ) | (349,776 | ) | (349,776 | ) | ||||||||||||||||||||
| Dividends paid | (147,087 | ) | (147,087 | ) | ||||||||||||||||||||||
| Change in fair value of interest rate swaps, net of taxes | 456 | 456 | ||||||||||||||||||||||||
| Net income | 532,357 | 532,357 | ||||||||||||||||||||||||
| Stockholders' equity at December 29, 2018 | 121,828 | $ | 1,375 | $ | 823,413 | $ | (2,480,677 | ) | $ | 3,814 | $ | 3,213,895 | $ | 1,561,820 |
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Fiscal Year | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| (52 weeks) | (52 weeks) | (53 weeks) | |||||||||
| Cash flows from operating activities: | |||||||||||
| Net income | $ | 532,357 | $ | 422,599 | $ | 437,120 | |||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | 177,351 | 165,834 | 142,958 | ||||||||
| (Gain) / loss on disposition of property and equipment | (567 | ) | 460 | 579 | |||||||
| Share-based compensation expense | 28,921 | 29,202 | 23,554 | ||||||||
| Deferred income taxes | 11,887 | 26,724 | 9,976 | ||||||||
| Change in assets and liabilities: | |||||||||||
| Inventories | (136,334 | ) | (83,552 | ) | (67,650 | ) | |||||
| Prepaid expenses and other current assets | (26,195 | ) | 2,305 | 1,782 | |||||||
| Accounts payable | 43,413 | 57,046 | 82,477 | ||||||||
| Accrued employee compensation | 22,373 | 6,427 | (18,237 | ) | |||||||
| Other accrued expenses | 36,406 | (10,338 | ) | 20,368 | |||||||
| Income taxes | (8,355 | ) | 4,210 | 11,787 | |||||||
| Other | 13,137 | 10,533 | 5,997 | ||||||||
| Net cash provided by operating activities | 694,394 | 631,450 | 650,711 | ||||||||
| Cash flows from investing activities: | |||||||||||
| Capital expenditures | (278,530 | ) | (250,401 | ) | (226,017 | ) | |||||
| Proceeds from sale of property and equipment | 2,216 | 11,220 | 362 | ||||||||
| Acquisition of Petsense, net of cash acquired | — | 1,225 | (143,610 | ) | |||||||
| Net cash used in investing activities | (276,314 | ) | (237,956 | ) | (369,265 | ) | |||||
| Cash flows from financing activities: | |||||||||||
| Borrowings under debt facilities | 1,193,500 | 1,180,000 | 945,000 | ||||||||
| Repayments under debt facilities | (1,212,250 | ) | (1,027,500 | ) | (820,000 | ) | |||||
| Debt issuance costs | (346 | ) | (599 | ) | (1,380 | ) | |||||
| Principal payments under capital lease obligations | (3,246 | ) | (2,446 | ) | (1,150 | ) | |||||
| Repurchase of shares to satisfy tax obligations | (1,367 | ) | (816 | ) | (843 | ) | |||||
| Repurchase of common stock | (349,776 | ) | (369,403 | ) | (331,708 | ) | |||||
| Net proceeds from issuance of common stock | 79,643 | 16,330 | 41,010 | ||||||||
| Cash dividends paid to stockholders | (147,087 | ) | (133,828 | ) | (122,272 | ) | |||||
| Net cash used in financing activities | (440,929 | ) | (338,262 | ) | (291,343 | ) | |||||
| Net change in cash and cash equivalents | (22,849 | ) | 55,232 | (9,897 | ) | ||||||
| Cash and cash equivalents at beginning of year | 109,148 | 53,916 | 63,813 | ||||||||
| Cash and cash equivalents at end of year | $ | 86,299 | $ | 109,148 | $ | 53,916 | |||||
| Supplemental disclosures of cash flow information: | |||||||||||
| Cash paid during the year for: | |||||||||||
| Interest | $ | 18,069 | $ | 10,481 | $ | 6,124 | |||||
| Income taxes | 146,918 | 219,081 | 232,258 | ||||||||
| Supplemental disclosures of non-cash activities: | |||||||||||
| Property and equipment acquired through capital lease | $ | — | $ | 11,395 | $ | 10,493 | |||||
| Non-cash accruals for construction in progress | 3,001 | 8,647 | 12,303 |
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRACTOR SUPPLY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Significant Accounting Policies:
Nature of Business
Founded in 1938, Tractor Supply Company (the “Company” or “we” or “our” or “us”) is the largest rural lifestyle retailer in the United States (“U.S.”). The Company is focused on supplying the needs of recreational farmers and ranchers and those who enjoy the rural lifestyle (which we refer to as the “Out Here” lifestyle), as well as tradesmen and small businesses. Stores are located primarily in towns outlying major metropolitan markets and in rural communities. The Company also owns and operates Petsense, LLC (“Petsense”), a small-box pet specialty supply retailer focused on meeting the needs of pet owners, primarily in small and mid-sized communities, and offering a variety of pet products and services. At December 29, 2018, the Company operated a total of 1,940 retail stores in 49 states (1,765 Tractor Supply and Del’s retail stores and 175 Petsense retail stores) and also offered an expanded assortment of products online at TractorSupply.com and Petsense.com.
Basis of Presentation
In the first quarter of fiscal 2018, the Company adopted accounting guidance that allowed for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the U.S. Tax Cuts and Jobs Act (the “TCJA”) as discussed in Note 15. This guidance was applied retrospectively, which resulted in the reclassification of $0.6 million from accumulated other comprehensive income to retained earnings in the Consolidated Balance Sheets, Statements of Stockholders’ Equity, and Statements of Comprehensive Income as of and for the fiscal year ended December 30, 2017. No other periods presented were affected by the adoption of this accounting guidance.
In the first quarter of fiscal 2017, the Company adopted accounting guidance which affected the presentation in the statement of cash flows of excess tax benefits or deficiencies from the exercise of stock options. The Company elected to apply the amendments using a retrospective transition method for all periods presented and therefore the presentation of previously reported excess tax benefits on the Consolidated Statements of Cash Flows has been changed to conform to the presentation used in the current period. As a result, $11.7 million of excess tax benefits related to share-based awards which were previously classified as cash flows from financing activities have been reclassified as cash flows from operating activities in the Consolidated Statements of Cash Flows for the fiscal year ended December 31, 2016. Additionally, beginning in fiscal 2017, the Consolidated Statements of Stockholders’ Equity are no longer impacted by the excess tax benefits or deficiencies from the exercise of stock options.
Fiscal Year
The Company’s fiscal year includes 52 or 53 weeks and ends on the last Saturday of the calendar year. The fiscal year ended December 29, 2018, consisted of 52 weeks, the fiscal year ended December 30, 2017, consisted of 52 weeks and the fiscal year ended December 31, 2016, consisted of 53 weeks.
Principles of Consolidation
The accompanying Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated.
Management Estimates
The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) inherently requires estimates and assumptions by management of the Company that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures. Actual results could differ from those estimates.
Significant estimates and assumptions by management primarily impact the following key financial statement areas:
Inventory Valuation
Inventory Impairment Risk
The Company identifies potentially excess and slow-moving inventory by evaluating turn rates, historical and expected future sales trends, age of merchandise, overall inventory levels, current cost of inventory, and other benchmarks. The Company
has established an inventory valuation reserve to recognize the estimated impairment in value (i.e., an inability to realize the full carrying value) based on the Company’s aggregate assessment of these valuation indicators under prevailing market conditions and current merchandising strategies. The Company does not believe its merchandise inventories are subject to significant risk of obsolescence in the near term. However, changes in market conditions or consumer purchasing patterns could result in the need for additional reserves.
Shrinkage
The Company performs physical inventories at least once a year for each store that has been open more than 12 months, and the Company has established a reserve for estimating inventory shrinkage between physical inventory counts. The reserve is established by assessing the chain-wide average shrinkage experience rate, applied to the related periods’ sales volumes. Such assessments are updated on a regular basis for the most recent individual store experiences. The estimated store inventory shrink rate is based on historical experience. The Company believes historical rates are a reasonably accurate reflection of future trends.
Vendor Funding
The Company receives funding from substantially all of its significant merchandise vendors, in support of its business initiatives, through a variety of programs and arrangements, including guaranteed vendor support funds (“vendor support”) and volume-based rebate funds (“volume rebates”). The amounts received are subject to terms of vendor agreements, most of which are “evergreen,” reflecting the on-going relationship with our significant merchandise vendors. Certain of the Company’s agreements, primarily volume rebates, are renegotiated annually, based on expected annual purchases of the vendor’s product. Vendor funding is initially deferred as a reduction of the purchase price of inventory, and then recognized as a reduction of cost of merchandise as the related inventory is sold.
During interim periods, the amount of vendor support and volume rebates are estimated based upon initial commitments and anticipated purchase levels with applicable vendors. The estimated purchase volume (and related vendor funding) is based on the Company’s current knowledge of inventory levels, sales trends and expected customer demand, as well as planned new store openings and relocations. Although the Company believes it can reasonably estimate purchase volume and related volume rebates at interim periods, it is possible that actual year-end results could be different from previously estimated amounts.
Freight
The Company incurs various types of transportation and delivery costs in connection with inventory purchases and distribution. Such costs are included as a component of the overall cost of inventories (on an aggregate basis) and recognized as a component of cost of merchandise sold as the related inventory is sold.
Self-Insurance Reserves
The Company self-insures a significant portion of its employee medical insurance, workers’ compensation insurance and general liability (including product liability) insurance plans. The Company has stop-loss insurance policies to protect it from individual losses over specified dollar values. For self-insured employee medical claims, we have a stop-loss limit of $300,000 per person per year. Our deductible or self-insured retention, as applicable, for each claim involving workers’ compensation insurance and general liability insurance is limited to $500,000 and our Texas Work Injury Policy is limited to $500,000. Further, we maintain a commercially reasonable umbrella/excess policy that covers liabilities in excess of the primary insurance policy limits.
The full extent of certain claims, especially workers’ compensation and general liability claims, may not become fully determined for several years. Therefore, the Company estimates potential obligations based upon historical claims experience, industry factors, severity factors, and other actuarial assumptions. Although the Company believes the reserves established for these obligations are reasonably estimated, any significant change in the number of claims or costs associated with claims made under these plans could have a material effect on the Company’s financial results. At December 29, 2018, the Company had net insurance reserves of $65.0 million compared to $57.9 million at December 30, 2017.
Impairment of Long-Lived Assets
Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
When evaluating long-lived assets for potential impairment, the Company first compares the carrying value of the asset to the asset’s estimated undiscounted future cash flows. The evaluation for long-lived assets is performed at the lowest level of identifiable cash flows, which is generally the individual store level. The significant assumptions used to determine estimated undiscounted cash flows include cash inflows and outflows directly resulting from the use of those assets in operations, including margin on net sales, payroll and related items, occupancy costs, insurance allocations and other costs to operate a store. If the estimated future cash flows are less than the carrying value of the asset, the Company calculates an impairment loss. The impairment loss calculation compares the carrying value of the asset to the asset’s estimated fair value, which may be based on an estimated future cash flow model. The Company recognizes an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If the Company recognizes an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated (amortized) over the remaining estimated useful life of that asset.
No significant impairment charges were recognized in fiscal 2018, 2017, or 2016. Impairment charges are included in selling, general and administrative (“SG&A”) expenses in the Consolidated Statements of Income.
Impairment of Indefinite-Lived Intangible Assets
Goodwill and other indefinite-lived intangible assets are evaluated for impairment annually, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
In accordance with the accounting standards, an entity has the option first to assess qualitative factors to determine whether events and circumstances indicate that it is more likely than not that goodwill or an indefinite-lived intangible asset is impaired. If after such assessment an entity concludes that the asset is not impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the asset using a quantitative impairment test, and if impaired, the associated assets must be written down to fair value.
The quantitative impairment test for goodwill compares the fair value of a reporting unit with the carrying value of its net assets, including goodwill. If the fair value of the reporting unit is less than the carrying value of the reporting unit, an impairment charge would be recorded to the Company’s operations, for the amount, if any, in which the carrying amount exceeds the reporting unit’s fair value. We determine fair values for each reporting unit using the market approach, when available and appropriate, or the income approach, or a combination of both. If multiple valuation methodologies are used, the results are weighted appropriately.
The quantitative impairment test for other indefinite-lived intangible assets involves comparing the carrying amount of the asset to the sum of the discounted cash flows expected to be generated by the asset. If the implied fair value of the indefinite-lived intangible asset is less than the carrying value, an impairment charge would be recorded to the Company’s operations.
No significant impairment charges were recognized in fiscal 2018, 2017, or 2016. Impairment charges are included in SG&A expenses in the Consolidated Statements of Income.
Revenue Recognition and Sales Returns
The Company recognizes revenue at the time the customer takes possession of merchandise. If the Company receives payment before completion of its customer obligations (as per the Company’s special order and layaway programs), the revenue is deferred until the customer takes possession of the merchandise and the sale is complete.
The Company is required to collect certain taxes and fees from customers on behalf of government agencies and remit such collections to the applicable governmental agency on a periodic basis. These taxes and fees are collected from customers at the time of purchase, but are not included in net sales. The Company records a liability upon collection from the customer and relieves the liability when payments are remitted to the applicable governmental agency.
The Company estimates a liability for sales returns based on a rolling average of historical return trends, and the Company believes that its estimate for sales returns is an accurate reflection of future returns associated with past sales. However, as with any estimate, refund activity may vary from estimated amounts. The Company had a liability for sales returns of $11.3 million and $3.8 million as of December 29, 2018 and December 30, 2017, respectively.
The Company recognizes revenue when a gift card or merchandise return card is redeemed by the customer and recognizes income when the likelihood of the gift card or merchandise return card being redeemed by the customer is remote (referred to as
“breakage”). The gift cards and merchandise return card breakage rate is based upon historical redemption patterns and income is recognized for unredeemed gift cards and merchandise return cards in proportion to those historical redemption patterns. The Company recognized breakage income of $2.6 million, $2.4 million, and $1.9 million in fiscal 2018, 2017, and 2016, respectively.
Cost of Merchandise Sold
Cost of merchandise sold includes the total cost of products sold; freight and duty expenses associated with moving merchandise inventories from vendors to distribution facilities, from distribution facilities to retail stores, from one distribution facility to another, and directly to our customers; vendor support; damaged, junked or defective product; cash discounts from payments to merchandise vendors; and adjustments for shrinkage (physical inventory losses), lower of cost or net realizable value, slow moving product and excess inventory quantities.
Selling, General and Administrative Expenses
SG&A expenses include payroll and benefit costs for retail, distribution facility, and corporate employees; share-based compensation expenses; occupancy costs of retail, distribution, and corporate facilities; advertising; tender costs, including bank charges and costs associated with credit and debit card interchange fees; outside service fees; and other administrative costs, such as computer maintenance, supplies, travel, and lodging.
Advertising Costs
Advertising costs consist of expenses incurred in connection with newspaper circulars and customer-targeted direct mail, as well as limited television, radio, digital and social media offerings, and other promotions. Costs are expensed when incurred with the exception of television advertising and circular and direct mail promotions, which are expensed upon first showing. Advertising expenses were approximately $83.4 million, $81.3 million, and $84.2 million for fiscal 2018, 2017, and 2016, respectively. Prepaid advertising costs were approximately $1.3 million and $1.1 million as of December 29, 2018, and December 30, 2017, respectively.
Warehousing and Distribution Facility Costs
Costs incurred at the Company’s distribution facilities for receiving, warehousing, and preparing product for delivery are expensed as incurred and are included in SG&A expenses in the Consolidated Statements of Income. Because the Company does not include these costs in cost of sales, the Company’s gross margin may not be comparable to other retailers that include these costs in the calculation of gross margin. Distribution facility costs including depreciation were approximately $209.7 million, $182.1 million, and $166.8 million for fiscal 2018, 2017, and 2016, respectively.
Pre-Opening Costs
Non-capital expenditures incurred in connection with opening new stores, primarily payroll and rent, are expensed as incurred. Pre-opening costs were approximately $8.5 million, $10.8 million, and $9.9 million for fiscal 2018, 2017, and 2016, respectively.
Share-Based Compensation
The Company has share-based compensation plans covering certain members of management and non-employee directors, which include incentive and non-qualified stock options, restricted stock units, and performance-based restricted share units. In addition, the Company offers an Employee Stock Purchase Plan (“ESPP”) to most employees that work at least 20 hours per week.
The Company estimates the fair value of its stock option awards at the date of grant utilizing a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of short-term traded options that have no vesting restrictions and are fully transferable. However, key assumptions used in the Black-Scholes model are adjusted to incorporate the unique characteristics of the Company’s stock option awards. Option pricing models and generally accepted valuation techniques require management to make subjective assumptions including expected stock price volatility, expected dividend yield, risk-free interest rate, and expected term. The Company relies on historical volatility trends to estimate future volatility assumptions. The risk-free interest rates used were actual U.S. Treasury Constant Maturity rates for bonds matching the expected term of the option on the date of grant. The expected term of the option on the date of grant was estimated based on the Company’s historical experience for similar options.
In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation (which is based on historical experience for similar options) is a critical assumption, as it reduces expense ratably over the vesting period.
The Company adjusts this estimate periodically, based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate.
The fair value of the Company’s restricted stock units and performance-based restricted share units is the closing stock price of the Company’s common stock the day preceding the grant date, discounted for the expected dividend yield over the term of the award.
The Company believes its estimates are reasonable in the context of historical experience. Future results will depend on, among other matters, levels of share-based compensation granted in the future, actual forfeiture rates, and the timing of option exercises.
Depreciation and Amortization
Depreciation includes expenses related to all retail, distribution facility, and corporate assets. Amortization includes expenses related to definite-lived intangible assets.
Income Taxes
The Company uses the asset and liability method to account for income taxes whereby deferred tax assets and liabilities are determined based on differences between the financial carrying amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates and laws that are anticipated to be in effect when temporary differences reverse or are settled. The effect of a tax rate change is recognized in the period in which the law is enacted in the provision for income taxes. The Company records a valuation allowance when it is more likely than not that a deferred tax asset will not be realized.
Tax Contingencies
The Company’s income tax returns are periodically audited by U.S. federal and state tax authorities. These audits include questions regarding tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any time, multiple tax years are subject to audit by the various tax authorities. In evaluating the exposures associated with the Company’s various tax filing positions, the Company records a liability for uncertain tax positions taken or expected to be taken in a tax return. A number of years may elapse before a particular matter, for which the Company has established a reserve, is audited and fully resolved or clarified. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company adjusts its tax contingencies reserve and income tax provision in the period in which actual results of a settlement with tax authorities differs from the established reserve, the statute of limitations expires for the relevant tax authority to examine the tax position or when more information becomes available.
Sales Tax Audit Reserve
A portion of the Company’s sales are to tax-exempt customers, predominantly agricultural-based. The Company obtains exemption information as a necessary part of each tax-exempt transaction. Many of the states in which the Company conducts business will perform audits to verify the Company’s compliance with applicable sales tax laws. The business activities of the Company’s customers and the intended use of the unique products sold by the Company create a challenging and complex tax compliance environment. These circumstances also create some risk that the Company could be challenged as to the accuracy of the Company’s sales tax compliance.
The Company reviews past audit experience and assessments with applicable states to continually determine if it has potential exposure for non-compliance. Any estimated liability is based on an initial assessment of compliance risk and historical experience with each state. The Company continually reassesses the exposure based on historical audit results, changes in policies, preliminary and final assessments made by state sales tax auditors, and additional documentation that may be provided to reduce the assessment. The reserve for these tax audits can fluctuate depending on numerous factors, including the complexity of agricultural-based exemptions, the ambiguity in state tax regulations, the number of ongoing audits, and the length of time required to settle with the state taxing authorities.
Net Income Per Share
Basic net income per share is calculated by dividing net income by the weighted average number of shares outstanding during the period. Diluted net income per share is calculated by dividing net income by the weighted average diluted shares outstanding. Dilutive shares are computed using the treasury stock method for stock options, restricted stock units, and performance-based restricted share units. Performance-based restricted share units are included in diluted shares only if the relative performance conditions have been considered satisfied as of the end of the reporting period.
Cash and Cash Equivalents
Temporary cash investments, with a maturity of three months or less when purchased, are considered to be cash equivalents. The majority of payments due from banks for customer credit cards are classified as cash and cash equivalents, as they generally settle within 24-48 hours.
Sales generated through the Company’s private label credit cards are not reflected as accounts receivable. Under an agreement with Citi Cards, a division of Citigroup, consumer and business credit is extended directly to customers by Citigroup. All credit program and related services are performed and controlled directly by Citigroup. Payments due from Citigroup are classified as cash and cash equivalents as they generally settle within 24-48 hours.
Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The Company uses a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The Company’s financial instruments consist of cash and cash equivalents, short-term receivables, trade payables, debt instruments, and interest rate swaps. Due to their short-term nature, the carrying values of cash and cash equivalents, short-term receivables, and trade payables approximate current fair value at each balance sheet date. The Company had $408.8 million and $427.5 million in borrowings under our debt facilities (as discussed in Note 5) as of December 29, 2018 and December 30, 2017, respectively. Based on current market interest rates (Level 2 inputs), the carrying value of our borrowings under our debt facilities approximates fair value for each period reported. The fair value of the Company’s interest rate swaps is determined based on the present value of expected future cash flows using forward rate curves (a Level 2 input). As described in further detail in Note 6, the fair value of the interest rate swaps, excluding accrued interest, was a $5.8 million and $5.2 million asset as of December 29, 2018 and December 30, 2017, respectively.
Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with applicable accounting standards for such instruments and hedging activities, which require that all derivatives are recorded on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.
Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge a certain portion of its risk, even though hedge accounting does not apply or the Company elects not to apply the hedge accounting standards.
Inventories
Inventories are stated at the lower of cost, as determined by the average cost method, or net realizable value. Inventory cost consists of the direct cost of merchandise including freight. Inventories are net of shrinkage, obsolescence, other valuations, and vendor allowances.
Property and Equipment
Property and equipment are carried at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets. Improvements to leased premises are amortized using the straight-line method over the initial term of the lease or the useful life of the improvement, whichever is less. The following estimated useful lives are generally applied:
| Life | |
| Buildings | 30 – 35 years |
| Leasehold and building improvements | 1 – 35 years |
| Furniture, fixtures and equipment | 5 – 10 years |
| Computer software and hardware | 2 – 7 years |
The Company entered into agreements with various governmental entities in the states of Kentucky, Georgia, and Tennessee to implement tax abatement plans related to its distribution center in Franklin, Kentucky (Simpson County), its distribution center in Macon, Georgia (Bibb County), and its Store Support Center in Brentwood, Tennessee (Williamson County). The tax abatement plans provide for reduction of real property taxes for specified time frames by legally transferring title to its real property in exchange for industrial revenue bonds. This property was then leased back to the Company. No cash was exchanged.
The lease payments are equal to the amount of the payments on the bonds. The tax abatement period extends through the term of the lease, which coincides with the maturity date of the bonds. At any time, the Company has the option to purchase the real property by paying off the bonds, plus $1. The terms and amounts authorized and drawn under each industrial revenue bond agreement are outlined as follows, as of December 29, 2018:
| Bond Term | Bond Authorized Amount (in millions) | Amount Drawn (in millions) | ||||
| Franklin, Kentucky Distribution Center | 30 years | $54.0 | $51.8 | |||
| Macon, Georgia Distribution Center | 15 years | $58.0 | $49.9 | |||
| Brentwood, Tennessee Store Support Center | 10 years | $78.0 | $75.3 |
Due to the form of these transactions, the Company has not recorded the bonds or the lease obligation associated with the sale lease-back transaction. The original cost of the Company’s property and equipment is recorded on the balance sheet and is being depreciated over its estimated useful life.
Capitalized Software Costs
The Company capitalizes certain costs related to the acquisition and development of software and amortizes these costs using the straight-line method over the estimated useful life of the software, which is two to seven years. Computer software consists of software developed for internal-use and third-party software purchased for internal-use. A subsequent addition, modification or upgrade to internal-use software is capitalized to the extent that it enhances the software’s functionality or extends its useful life. These costs are included in computer software and hardware in the accompanying Consolidated Balance Sheets. Certain software costs not meeting the criteria for capitalization are expensed as incurred.
Store Closing Costs
The Company regularly evaluates the performance of its stores and periodically closes those stores that are underperforming. The Company records a liability for costs associated with an exit or disposal activity when the liability is incurred, usually in the period the store closes. Store closing costs were not significant to the results of operations for any of the fiscal years presented.
Leases
Assets under capital leases are amortized in accordance with the Company’s normal depreciation policy for owned assets or over the lease term, if shorter, and the related charge to operations is included in depreciation expense in the Consolidated Statements of Income.
Certain operating leases include rent increases during the lease term. For these leases, the Company recognizes the related rental expense on a straight-line basis over the term of the lease (which includes the pre-opening period of construction, renovation, fixture and merchandise placement) and records the difference between the expense charged to operations and amounts paid as a deferred rent liability.
The Company occasionally receives reimbursements from landlords to be used towards improving the related store to be leased. Leasehold improvements are recorded at their gross costs, including items reimbursed by landlords. Related reimbursements are deferred and amortized on a straight-line basis as a reduction of rent expense over the applicable lease term.
Note 2 – Share-Based Compensation:
Share-based compensation includes stock options, restricted stock units, performance-based restricted share units, and certain transactions under the Company’s ESPP. Share-based compensation expense is recognized based on the grant date fair value of all stock options, restricted stock units, and performance-based restricted share units plus a discount on shares purchased by employees as a part of the ESPP. The discount under the ESPP represents the difference between the purchase date market value and the employee’s purchase price.
There were no significant modifications to the Company’s share-based compensation plans during fiscal 2017 or 2016. In fiscal 2018, there were no significant modifications to the Company’s share-based compensation plans prior to May 10, 2018, when the Company’s shareholders approved the 2018 Omnibus Incentive Plan (the “2018 Plan”) replacing the 2009 Stock Incentive Plan. Following the adoption of the 2018 Plan, no further grants may be made under the 2009 Stock Incentive Plan. Subject to adjustment as provided by the terms of the 2018 Plan, the maximum number of shares of common stock with respect to which awards may be granted under the 2018 Plan is 12,562,318. The maximum number of shares with respect to which awards may be granted under the 2018 Plan shall be increased by the number of shares with respect to which options or other awards were granted under the 2009 Stock Incentive Plan or the 2006 Stock Incentive Plan but which terminate, expire unexercised, or are settled for cash, forfeited, or canceled without the delivery of shares after the effective date of the 2018 Plan.
Under our 2018 Plan, awards may be granted to officers, non-employee directors, other employees, and independent contractors. The per share exercise price of options granted shall not be less than the fair market value of the stock on the date of grant and such awards will expire no later than ten years from the date of grant. Vesting of awards commences at various anniversary dates following the dates of each grant and certain awards will vest only upon established performance conditions being met. At December 29, 2018, the Company had approximately 12.7 million shares available for future equity awards under the Company’s 2018 Plan.
Share-based compensation expense, including changes in expense for modifications, if any, of awards, was $28.9 million, $29.2 million, and $23.6 million for fiscal 2018, 2017, and 2016, respectively.
Stock Options
Under the Company’s share-based compensation plans, options may be granted to current or prospective officers or employees, non-employee directors, and independent contractors. The per share exercise price of options granted shall not be less than the fair market value of the stock on the date of grant and such options will expire no later than ten years from the date of grant. Vesting of options commences at various anniversary dates following the dates of grant.
The fair value is separately estimated for each option grant. The fair value of each option is recognized as compensation expense ratably over the vesting period. The Company has estimated the fair value of all stock option awards as of the date of the grant by applying a Black-Scholes pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. The ranges of key assumptions used in determining the fair value of options granted during fiscal 2018, 2017, and 2016, as well as a summary of the methodology applied to develop each assumption, are as follows:
| Fiscal Year | ||||||||
| 2018 | 2017 | 2016 | ||||||
| Expected price volatility | 26.4 - 27.0% | 25.1 - 26.0% | 25.5 - 27.9% | |||||
| Risk-free interest rate | 2.5 - 3.0% | 1.7 - 1.9% | 0.9 - 1.3% | |||||
| Weighted average expected term (in years) | 4.5 | 4.4 | 4.4 | |||||
| Forfeiture rate | 7.3 | % | 7.2 | % | 7.1 | % | ||
| Dividend yield | 1.6 | % | 1.3 | % | 0.9 | % |
Expected Price Volatility — This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. The Company applies a historical volatility rate. To calculate historical changes in market value, the Company uses daily market value changes from the date of grant over a past period generally representative of the expected life of the options to determine volatility. The Company believes the use of historical price volatility provides an appropriate indicator of future volatility. An increase in the expected volatility will increase compensation expense.
Risk-Free Interest Rate — This is the U.S. Treasury Constant Maturity rate over a term equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense.
Weighted Average Expected Term — This is the period of time over which the options granted are expected to remain outstanding and is based on historical experience. Options granted generally have a maximum term of ten years. An increase in the expected term will increase compensation expense.
Forfeiture Rate — This is the estimated percentage of options granted that are expected to be forfeited or canceled before becoming fully vested. This estimate is based on historical experience. An increase in the forfeiture rate will decrease compensation expense.
Dividend Yield — This is the estimated dividend yield for the weighted average expected term of the option granted. An increase in the dividend yield will decrease compensation expense.
The Company issues shares for options when exercised. A summary of stock option activity is as follows:
| Stock Option Activity | Options | Weighted Average Exercise Price | Weighted Average Fair Value | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value (in thousands) | ||||||||||||
| Outstanding at December 30, 2017 | 4,998,526 | $ | 68.46 | 6.9 | $ | 50,145 | |||||||||||
| Granted | 693,634 | 67.81 | $ | 15.02 | |||||||||||||
| Exercised | (1,380,136 | ) | 54.55 | ||||||||||||||
| Canceled | (258,638 | ) | 77.83 | ||||||||||||||
| Outstanding at December 29, 2018 | 4,053,386 | $ | 72.49 | 7.0 | $ | 46,472 | |||||||||||
| Exercisable at December 29, 2018 | 2,173,274 | $ | 72.32 | 5.8 | $ | 25,747 |
The aggregate intrinsic values in the table above represent the total difference between the Company’s closing stock price at each year-end and the option exercise price, multiplied by the number of in-the-money options at each year-end. As of December 29, 2018, total unrecognized compensation expense related to non-vested stock options was approximately $12.3 million with a weighted average expense recognition period of 1.6 years.
There were no material modifications to options in fiscal 2018, 2017, or 2016.
Other information relative to options activity during fiscal 2018, 2017, and 2016 is as follows (in thousands):
| Fiscal Year | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Total fair value of stock options vested | $ | 18,247 | $ | 15,996 | $ | 15,184 | |||||
| Total intrinsic value of stock options exercised | $ | 43,476 | $ | 9,237 | $ | 39,696 |
Restricted Stock Units
The Company issues shares for restricted stock units once vesting occurs and related restrictions lapse. The fair value of the restricted stock units is the closing price of the Company’s common stock the day preceding the grant date, discounted for the expected dividend yield over the term of the award. The units vest over a one to three-year term; some plan participants have elected to defer receipt of shares of common stock upon vesting of restricted stock units, and as a result, those shares are not issued until a later date. A summary of restricted stock unit activity is presented below:
| Restricted Stock Unit Activity | Restricted Stock Units | Weighted Average Grant Date Fair Value | |||||
| Restricted at December 30, 2017 | 223,230 | $ | 67.92 | ||||
| Granted | 309,978 | 64.00 | |||||
| Exercised | (70,845 | ) | 75.16 | ||||
| Forfeited | (24,293 | ) | 65.84 | ||||
| Restricted at December 29, 2018 | 438,070 | $ | 64.09 |
Other information relative to restricted stock unit activity during fiscal 2018, 2017, and 2016 is as follows (in thousands):
| Fiscal Year | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Total grant date fair value of restricted stock units vested and issued | $ | 5,325 | $ | 3,301 | $ | 3,072 | |||||
| Total intrinsic value of restricted stock units vested and issued | $ | 5,364 | $ | 3,465 | $ | 5,104 |
For the majority of restricted stock units granted, the number of shares issued on the date the restricted stock units vest is net of shares withheld by the Company to satisfy the minimum statutory tax withholding requirements, which the Company pays on behalf of its employees. The Company issued 53,714, 39,314, and 48,267 shares as a result of vested restricted stock units during fiscal 2018, 2017, and 2016, respectively. Although shares withheld are not issued, they are treated similar to common stock repurchases as they reduce the number of shares that would have been issued upon vesting. The amounts are net of 17,131, 11,755, and 10,236 shares withheld to satisfy $1.4 million of employees’ tax obligations during fiscal 2018 and $0.8 million during both fiscal 2017 and 2016.
There were no material modifications to restricted stock units in fiscal 2018, 2017, or 2016.
As of December 29, 2018, total unrecognized compensation expense related to non-vested restricted stock units was approximately $13.5 million with a weighted average expense recognition period of 2.0 years.
Performance-Based Restricted Share Units
We issue performance-based restricted share units to senior executives that represent shares potentially issuable in the future, subject to the achievement of specified performance goals. The performance metrics for the units are growth in net sales and growth in earnings per diluted share over a one-year performance period. Issuance is based upon the level of achievement of the relative performance targets. If the performance targets are achieved, the units will vest on a pro-rata basis over a three-year period. The fair value of the performance-based restricted share units is the closing price of the Company’s common stock the day preceding the grant date, discounted for the expected dividend yield over the term of the awards. A summary of performance-based restricted share unit activity is presented below:
| Performance-Based Restricted Share Unit Activity | Performance-Based Restricted Share Units | Weighted Average Grant Date Fair Value | |||||
| Restricted at December 30, 2017 | — | $ | — | ||||
| Granted (a) | 41,310 | 63.90 | |||||
| Exercised | — | — | |||||
| Forfeited | — | — | |||||
| Restricted at December 29, 2018 | 41,310 | $ | 63.90 |
(a)Assumes 100% target level achievement of the relative performance targets. The actual number of shares that will be issued, which may be higher or lower than the target, will be determined by the level of achievement of the relative performance targets.
There were no vested or issued performance-based restricted share units as of fiscal 2018, 2017, or 2016, and as such, there was no associated fair value or intrinsic value for these awards.
There were no material modifications to performance-based restricted share units in fiscal 2018, 2017, or 2016.
As of December 29, 2018, total unrecognized compensation expense related to non-vested performance-based restricted share units was approximately $1.3 million with a weighted average expense recognition period of 2.2 years.
Employee Stock Purchase Plan
The ESPP provides Company employees the opportunity to purchase, through payroll deductions, shares of common stock at a 15% discount. Pursuant to the terms of the ESPP, the Company issued 77,458, 83,155, and 69,562 shares of common stock during fiscal 2018, 2017, and 2016, respectively. The total cost related to the ESPP, including the compensation expense calculations, was approximately $1.1 million, $1.0 million, and $1.1 million in fiscal 2018, 2017, and 2016, respectively. There is a maximum of 16.0 million shares of common stock that are reserved under the ESPP. At December 29, 2018, there were approximately 11.9 million remaining shares of common stock reserved for future issuance under the ESPP.
Note 3 – Acquisition of Petsense:
On September 29, 2016, the Company completed the acquisition of Petsense. Headquartered in Scottsdale, Arizona, Petsense is a small-box pet specialty supply retailer focused on meeting the needs of pet owners, primarily in small and mid-size communities, and offering a variety of pet products and services. Pursuant to the agreement governing the transaction, the Company acquired all the outstanding equity interests in Petsense for an all-cash purchase price which was financed with cash on-hand and revolver borrowings under the 2016 Senior Credit Facility (as defined in Note 5).
The total consideration transferred in connection with the Petsense acquisition has been allocated to the assets acquired and liabilities assumed based upon their respective fair values. The fair value of the assets acquired and liabilities assumed is estimated based on either one or a combination of the following methodologies: the income approach, the cost approach or the market approach as determined based on the nature of the asset or liability and the level of inputs available. With respect to assets and liabilities, the determination of fair value requires management to make subjective judgments as to projections of future operating performance, the appropriate discount rate to apply, long-term growth rates, etc. (i.e. unobservable inputs classified as Level 3 inputs under the fair value hierarchy), which affect the amounts recorded in the purchase price allocation. The excess of the consideration transferred over the fair value of the identifiable assets, net of liabilities, is recorded as goodwill, which is indicative of the expected continued growth and development of the pet specialty retail business acquired.
The table below summarizes the consideration transferred and allocation of the purchase price for the Petsense acquisition (in thousands):
| Consideration transferred | $ | 144,476 | |
| Assets acquired: | |||
| Current assets | $ | 21,875 | |
| Property and equipment | 25,519 | ||
| Other intangible assets - tradename | 31,300 | ||
| Other assets | 428 | ||
| Liabilities assumed: | |||
| Current liabilities | (12,091 | ) | |
| Long-term liabilities | (5,489 | ) | |
| Total identifiable net assets acquired | 61,542 | ||
| Excess of consideration transferred over identifiable net assets acquired (goodwill) | $ | 82,934 |
In September 2017, the Company finalized the working capital settlement pursuant to the agreement governing the transaction. As a result, the values of the consideration transferred, assets acquired and liabilities assumed as reflected in the table above are considered final. The working capital settlement reduced both the consideration transferred and goodwill by $1.2 million from the preliminary values.
The resulting goodwill of $82.9 million and tradename of $31.3 million are amortized for income tax purposes.
The results of operations of Petsense have been included in the Consolidated Financial Statements since the date of acquisition.
Note 4 – Goodwill and Other Intangible Assets:
Goodwill
The Company had approximately $93.2 million of goodwill at December 29, 2018 and December 30, 2017. The changes in the carrying amount of goodwill for the years ended December 29, 2018 and December 30, 2017, are as follows (in thousands):
| Fiscal Year | |||||||
| 2018 | 2017 | ||||||
| Balance, beginning of year | $ | 93,192 | $ | 94,417 | |||
| Working capital settlement | — | (1,225 | ) | ||||
| Balance, end of year | $ | 93,192 | $ | 93,192 |
Goodwill is allocated to each identified reporting unit, which is defined as an operating segment or one level below the operating segment.
Goodwill is not amortized, but is evaluated for impairment annually and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. The Company completes its impairment evaluation by performing valuation analyses and considering other publicly available market information, as appropriate.
The test used to identify the potential for goodwill impairment compares the fair value of a reporting unit with its carrying value. An impairment charge would be recorded to the Company’s operations for the amount, if any, in which the carrying value exceeds the fair value.
In the fourth quarter of fiscal 2018, the Company completed its annual impairment testing of goodwill and no impairment was identified. The Company determined that the fair value of each reporting unit (including goodwill) was in excess of the carrying value of the respective reporting unit. In reaching this conclusion, the fair value of each reporting unit was determined based on either a market or an income approach. Under the market approach, the fair value is based on observed market data.
Other Intangible Assets
The Company had approximately $31.3 million of intangible assets other than goodwill at December 29, 2018 and December 30, 2017. The intangible asset balance represents the estimated fair value of the Petsense tradename, which is not subject to amortization as it has an indefinite useful life on the basis that it is expected to contribute cash flows beyond the foreseeable horizon.
With respect to intangible assets, we evaluate for impairment annually and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We recognize an impairment loss only if the carrying amount is not recoverable through its discounted cash flows and measure the impairment loss based on the difference between the carrying value and fair value. In the fourth quarter of fiscal 2018, the Company completed its annual impairment testing of intangible assets and no impairment was identified.
Note 5 – Debt:
The following table summarizes the Company’s outstanding debt as of the dates indicated (in millions):
| December 29, 2018 | December 30, 2017 | |||||||
| Senior Notes | $ | 150.0 | $ | 150.0 | ||||
| Senior Credit Facility: | ||||||||
| February 2016 Term Loan | 165.0 | 180.0 | ||||||
| June 2017 Term Loan | 93.8 | 97.5 | ||||||
| Revolving credit loans | — | — | ||||||
| Total outstanding borrowings | 408.8 | 427.5 | ||||||
| Less: unamortized debt issuance costs | (1.4 | ) | (1.4 | ) | ||||
| Total debt | 407.4 | 426.1 | ||||||
| Less: current portion of long-term debt | (26.3 | ) | (25.0 | ) | ||||
| Long-term debt | $ | 381.1 | $ | 401.1 | ||||
| Outstanding letters of credit | $ | 33.5 | $ | 39.6 |
Senior Notes
On August 14, 2017, the Company entered into a note purchase and private shelf agreement (the “Note Purchase Agreement”), pursuant to which the Company agreed to sell $150 million aggregate principal amount of senior unsecured notes due August 14, 2029 (the “2029 Notes”) in a private placement. The 2029 Notes bear interest at 3.70% per annum with interest payable semi-annually in arrears on each annual and semi-annual anniversary of the issuance date. The obligations under the Note Purchase Agreement are unsecured, but guaranteed by each of the Company’s material subsidiaries.
The Company may from time to time issue and sell additional senior unsecured notes (the “Shelf Notes”) pursuant to the Note Purchase Agreement, in an aggregate principal amount of up to $150 million. The Shelf Notes will have a maturity date of no more than 12 years after the date of original issuance and may be issued through August 14, 2020, unless earlier terminated in accordance with the terms of the Note Purchase Agreement.
Pursuant to the Note Purchase Agreement, the 2029 Notes and any Shelf Notes (collectively, the "Notes") are redeemable by the Company, in whole at any time or in part from time to time, at 100% of the principal amount of the Notes being redeemed, together with accrued and unpaid interest thereon and a make whole amount calculated by discounting all remaining scheduled payments on the Notes by the yield on the U.S. Treasury security with a maturity equal to the remaining average life of the Notes plus 0.50%.
Senior Credit Facility
On February 19, 2016, the Company entered into a senior credit facility (the “2016 Senior Credit Facility”) consisting of a $200 million term loan (the “February 2016 Term Loan”) and a $500 million revolving credit facility (the “Revolver”) with a sublimit of $50 million for swingline loans. This agreement is unsecured. On February 16, 2018, the maturity date was extended from February 19, 2021 to February 19, 2022.
On June 15, 2017, pursuant to an accordion feature available under the 2016 Senior Credit Facility, the Company entered into an incremental term loan agreement (the “June 2017 Term Loan”) which increased the term loan capacity under the 2016 Senior Credit Facility by $100 million. This agreement is unsecured and matures on June 15, 2022.
The February 2016 Term Loan of $200 million requires quarterly payments totaling $10 million per year in years one and two and $20 million per year in years three through the maturity date, with the remaining balance due in full on the maturity date of February 19, 2022. The June 2017 Term Loan of $100 million requires quarterly payments totaling $5 million per year in years one and two and $10 million per year in years three through the maturity date, with the remaining balance due in full on the maturity date of June 15, 2022. The 2016 Senior Credit Facility also contains a $500 million revolving credit facility (with a sublimit of $50 million for swingline loans).
Borrowings under the February 2016 Term Loan and Revolver bear interest at either the bank’s base rate (5.500% at December 29, 2018) or the London Inter-Bank Offer Rate (“LIBOR”) (2.503% at December 29, 2018) plus an additional amount ranging from 0.500% to 1.125% per annum (0.750% at December 29, 2018), adjusted quarterly based on our leverage ratio. The Company is also required to pay, quarterly in arrears, a commitment fee for unused capacity ranging from 0.075% to 0.200% per annum (0.125% at December 29, 2018), adjusted quarterly based on the Company’s leverage ratio. Borrowings under the June 2017 Term Loan bear interest at either the bank’s base rate (5.500% at December 29, 2018) or LIBOR (2.503% at December 29, 2018) plus an additional 1.000% per annum. As further described in Note 6, the Company has entered into interest rate swap agreements in order to hedge our exposure to variable rate interest payments associated with each of the term loans under the 2016 Senior Credit Facility.
Proceeds from the 2016 Senior Credit Facility may be used for working capital, capital expenditures, dividends, share repurchases, and other matters. There are no compensating balance requirements associated with the 2016 Senior Credit Facility.
Covenants and Default Provisions of the Debt Agreements
The 2016 Senior Credit Facility and the Note Purchase Agreement (collectively, the “Debt Agreements”) require quarterly compliance with respect to two material covenants: a fixed charge coverage ratio and a leverage ratio. Both ratios are calculated on a trailing twelve-month basis at the end of each fiscal quarter. The fixed charge coverage ratio compares earnings before interest, taxes, depreciation, amortization, share-based compensation and rent expense (“consolidated EBITDAR”) to the sum of interest paid and rental expense (excluding any straight-line rent adjustments). The fixed charge coverage ratio shall be greater than or equal to 2.00 to 1.0 as of the last day of each fiscal quarter. The leverage ratio compares rental expense (excluding any straight-line rent adjustments) multiplied by a factor of six plus total debt to consolidated EBITDAR. The leverage ratio shall be less than or equal to 4.00 to 1.0 as of the last day of each fiscal quarter. The Debt Agreements also contain certain other restrictions regarding additional indebtedness, capital expenditures, business operations, guarantees, investments, mergers, consolidations and sales of assets, transactions with subsidiaries or affiliates, and liens. As of December 29, 2018, the Company was in compliance with all debt covenants.
The Debt Agreements contain customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to other material indebtedness, certain events of bankruptcy and insolvency, material judgments, certain ERISA events and invalidity of loan documents. Upon certain changes of control, payment under the Debt Agreements could become due and payable. In addition, under the Note Purchase Agreement, upon an event of default or change of control, the make whole payment described above may become due and payable.
The Note Purchase Agreement also requires that, in the event the Company amends its 2016 Senior Credit Facility, or any subsequent credit facility of $100 million or greater, such that it contains covenant or default provisions that are not provided in the Note Purchase Agreement or that are similar to those contained in the Note Purchase Agreement but which contain percentages, amounts, formulas or grace periods that are more restrictive than those set forth in the Note Purchase Agreement or are otherwise more beneficial to the lenders thereunder, the Note Purchase Agreement shall be automatically amended to include such additional or amended covenants and/or default provisions.
Note 6 – Interest Rate Swaps:
The Company entered into an interest rate swap agreement which became effective on March 31, 2016, with a maturity date of February 19, 2021. The notional amount of this swap agreement began at $197.5 million (the principal amount of the February 2016 Term Loan borrowings as of March 31, 2016) and will amortize at the same time and in the same amount as the February 2016 Term Loan borrowings as described in Note 5, up to the maturity date of the interest rate swap agreement on February 19, 2021. As of December 29, 2018, the notional amount of the interest rate swap was $165.0 million.
The Company entered into a second interest rate swap agreement which became effective on June 30, 2017, with a maturity date of June 15, 2022. The notional amount of this swap agreement began at $100 million (the principal amount of the June 2017 Term Loan borrowings as of June 30, 2017) and will amortize at the same time and in the same amount as the June 2017 Term Loan borrowings as described in Note 5. As of December 29, 2018, the notional amount of the interest rate swap was $93.8 million.
The Company’s interest rate swap agreements are executed for risk management and are not held for trading purposes. The objective of the interest rate swap agreements is to mitigate interest rate risk associated with future changes in interest rates. To accomplish this objective, the interest rate swap agreements are intended to hedge the variable cash flows associated with the variable rate term loan borrowings under the 2016 Senior Credit Facility. Both interest rate swap agreements entitle the Company
to receive, at specified intervals, a variable rate of interest based on LIBOR in exchange for the payment of a fixed rate of interest throughout the life of the agreement, without exchange of the underlying notional amount.
The Company has designated its interest rate swap agreements as cash flow hedges and accounts for the underlying activity in accordance with hedge accounting. The interest rate swaps are presented within the Consolidated Balance Sheets at fair value. In accordance with hedge accounting, the effective portion of gains and losses on interest rate swaps that are designated and qualify as cash flow hedges are recorded as a component of Other Comprehensive Income (“OCI”) and reclassified into earnings in the period during which the hedged transactions affect earnings. The ineffective portion of gains and losses on interest rate swaps, if any, are recognized in current earnings.
The assets measured at fair value related to the Company’s interest rate swaps, excluding accrued interest, were as follows (in thousands):
| Balance Sheet Location | December 29, 2018 | December 30, 2017 | ||||||||
| Interest rate swaps (short-term portion) | Other current assets | $ | 2,601 | $ | 900 | |||||
| Interest rate swaps (long-term portion) | Other assets | 3,222 | 4,252 | |||||||
| Total net assets | $ | 5,823 | $ | 5,152 |
The offset to the interest rate swap asset or liability is recorded as a component of equity, net of deferred taxes, in Accumulated Other Comprehensive Income (“AOCI”), and will be reclassified into earnings over the term of the underlying debt as interest payments are made.
The following table summarizes the changes in AOCI, net of tax, related to the Company’s interest rate swaps (in thousands):
| Fiscal Year | ||||||||
| 2018 | 2017 | |||||||
| Beginning fiscal year AOCI balance | $ | 3,358 | $ | 1,392 | ||||
| Current fiscal year gain recognized in OCI | 456 | 1,371 | ||||||
| Reclassification of stranded tax effects to retained earnings (a) | — | 595 | ||||||
| Other comprehensive gain, net of tax | 456 | 1,966 | ||||||
| Ending fiscal year AOCI balance | $ | 3,814 | $ | 3,358 |
(a) AOCI for the fiscal year ended December 30, 2017 has been adjusted from previously reported amounts as a result of the adoption of ASU 2018-02 as discussed in Notes 1 and 15 to the Consolidated Financial Statements.
Cash flows related to the interest rate swaps are included in operating activities on the Consolidated Statements of Cash Flows.
The following table summarizes the impact of pre-tax gains and losses derived from the Company’s interest rate swaps (in thousands):
| Fiscal Year | ||||||||||||||
| Financial Statement Location | 2018 | 2017 | 2016 | |||||||||||
| Effective portion of gains recognized in OCI during the period | Other comprehensive income | $ | 612 | $ | 2,240 | $ | 2,283 | |||||||
| Ineffective portion of gains recognized in earnings during the period | Interest expense, net | 59 | 95 | 534 |
The following table summarizes the impact of taxes affecting AOCI as a result of the Company’s interest rate swaps (in thousands):
| Fiscal Year | ||||||||
| 2018 | 2017 | |||||||
| Income tax expense of interest rate swaps on AOCI | $ | 156 | $ | 869 |
Credit-risk-related contingent features
In accordance with the underlying interest rate swap agreements, the Company could be declared in default on its interest rate swap obligations if repayment of the underlying indebtedness (i.e., the Company’s term loans) is accelerated by the lender due to the Company's default on such indebtedness.
If the Company had breached any of the provisions in the underlying agreements at December 29, 2018, it could have been required to post full collateral or settle its obligations under the Company’s interest rate swap agreements. However, as of December 29, 2018, the Company had not breached any of these provisions or posted any collateral related to the underlying interest rate swap agreements. Further, as of December 29, 2018, the net balance of each of the Company’s interest rate swaps were in a net asset position and therefore the Company would have no obligation upon default.
Note 7 – Leases:
The Company leases the majority of its retail store locations, two distribution sites, its Merchandise Innovation Center, transportation equipment, and other equipment under various non-cancellable operating leases. The leases have varying terms and expire at various dates through 2037. Store leases typically have initial terms of between 10 and 15 years, with two to four optional renewal periods of five years each. Some leases require the payment of contingent rent that is based upon store sales above agreed-upon sales levels for the year. The sales levels vary for each store and are established in the lease agreements. Generally, most of the leases also require that the Company pays associated taxes, insurance, and maintenance costs.
Total rent expense was approximately $342.2 million, $319.5 million, and $293.0 million for fiscal 2018, 2017, and 2016, respectively. Total contingent rent expense was insignificant for fiscal 2018, 2017, and 2016.
Future minimum payments, by year and in the aggregate, under leases with initial or remaining terms of one year or more consist of the following (in thousands):
| Capital Leases | Operating Leases | |||||||
| 2019 | $ | 5,215 | $ | 344,836 | ||||
| 2020 | 5,234 | 328,589 | ||||||
| 2021 | 5,294 | 306,572 | ||||||
| 2022 | 4,172 | 284,327 | ||||||
| 2023 | 2,980 | 260,518 | ||||||
| Thereafter | 20,169 | 1,175,972 | ||||||
| Total minimum lease payments | 43,064 | $ | 2,700,814 | |||||
| Amount representing interest | (10,148 | ) | ||||||
| Present value of minimum lease payments | 32,916 | |||||||
| Less: current portion | (3,646 | ) | ||||||
| Long-term capital lease obligations | $ | 29,270 |
Assets under capital leases were as follows (in thousands):
| December 29, 2018 | December 30, 2017 | ||||||
| Building and improvements, gross | $ | 29,324 | $ | 29,324 | |||
| Computer software and hardware | 11,388 | 11,388 | |||||
| Less: accumulated depreciation and amortization | (10,690 | ) | (6,462 | ) | |||
| Assets under capital lease, net | $ | 30,022 | $ | 34,250 |
Note 8 – Capital Stock and Dividends:
Capital Stock
The authorized capital stock of the Company consists of common stock and preferred stock. The Company is authorized to issue 400 million shares of common stock. The Company is also authorized to issue 40 thousand shares of preferred stock, with such designations, rights and preferences as may be determined from time to time by the Company’s Board of Directors.
Dividends
During fiscal 2018 and 2017, the Company’s Board of Directors declared the following cash dividends:
| Date Declared | Dividend Amount Per Share | Stockholders of Record Date | Date Paid | |||
| November 7, 2018 | $0.31 | November 26, 2018 | December 11, 2018 | |||
| August 8, 2018 | $0.31 | August 27, 2018 | September 11, 2018 | |||
| May 9, 2018 | $0.31 | May 29, 2018 | June 12, 2018 | |||
| February 7, 2018 | $0.27 | February 26, 2018 | March 13, 2018 | |||
| November 6, 2017 | $0.27 | November 20, 2017 | December 5, 2017 | |||
| August 7, 2017 | $0.27 | August 21, 2017 | September 6, 2017 | |||
| May 8, 2017 | $0.27 | May 22, 2017 | June 6, 2017 | |||
| February 8, 2017 | $0.24 | February 27, 2017 | March 14, 2017 |
It is the present intention of the Company’s Board of Directors to continue to pay a quarterly cash dividend; however, the declaration and payment of future dividends will be determined by the Company’s Board of Directors in its sole discretion and will depend upon the earnings, financial condition, and capital needs of the Company, as well as other factors which the Company’s Board of Directors deem relevant.
On February 6, 2019, the Company’s Board of Directors declared a quarterly cash dividend of $0.31 per share of the Company’s common stock. The dividend will be paid on March 12, 2019, to stockholders of record as of the close of business on February 25, 2019.
Note 9 – Treasury Stock:
The Company’s Board of Directors has authorized common stock repurchases under a share repurchase program of up to $3 billion, exclusive of any fees, commissions or other expenses related to such repurchases through December 31, 2020. The repurchases may be made from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares repurchased under the program will depend on a variety of factors, including price, corporate and regulatory requirements, capital availability and other market conditions. Repurchased shares are accounted for at cost and will be held in treasury for future issuance. The program may be limited or terminated at any time without prior notice.
The Company repurchased approximately 5.0 million, 5.9 million, and 4.4 million shares of common stock under the share repurchase program at a total cost of $349.8 million, $369.4 million, and $331.7 million in fiscal 2018, 2017, and 2016, respectively. As of December 29, 2018, the Company had remaining authorization under the share repurchase program of $520.0 million, exclusive of any fees, commissions or other expenses.
Note 10 – Net Income Per Share:
Net income per share is calculated as follows (in thousands, except per share amounts):
| Fiscal Year | ||||||||||
| 2018 | ||||||||||
| Net Income | Shares | Per Share Amount | ||||||||
| Basic net income per share | $ | 532,357 | 122,651 | $ | 4.34 | |||||
| Dilutive stock options and other share-based awards outstanding | — | 820 | (0.03 | ) | ||||||
| Diluted net income per share | $ | 532,357 | 123,471 | $ | 4.31 |
| Fiscal Year | ||||||||||
| 2017 | ||||||||||
| Net Income | Shares | Per Share Amount | ||||||||
| Basic net income per share | $ | 422,599 | 127,588 | $ | 3.31 | |||||
| Dilutive stock options and other share-based awards outstanding | — | 616 | (0.01 | ) | ||||||
| Diluted net income per share | $ | 422,599 | 128,204 | $ | 3.30 |
| Fiscal Year | ||||||||||
| 2016 | ||||||||||
| Net Income | Shares | Per Share Amount | ||||||||
| Basic net income per share | $ | 437,120 | 132,905 | $ | 3.29 | |||||
| Dilutive stock options and other share-based awards outstanding | — | 908 | (0.02 | ) | ||||||
| Diluted net income per share | $ | 437,120 | 133,813 | $ | 3.27 |
Anti-dilutive stock awards excluded from the above calculations totaled approximately 3.1 million, 3.9 million, and 1.9 million shares in fiscal 2018, 2017, and 2016, respectively.
Note 11 – Income Taxes:
The provision for income taxes consists of the following (in thousands):
| Fiscal Year | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Current tax expense: | |||||||||||
| Federal | $ | 123,388 | $ | 207,986 | $ | 221,207 | |||||
| State | 15,597 | 14,516 | 20,858 | ||||||||
| Total current | 138,985 | 222,502 | 242,065 | ||||||||
| Deferred tax expense (benefit): | |||||||||||
| Federal | 9,650 | 22,469 | 12,256 | ||||||||
| State | 2,393 | 4,953 | (3,171 | ) | |||||||
| Total deferred | 12,043 | 27,422 | 9,085 | ||||||||
| Total provision | $ | 151,028 | $ | 249,924 | $ | 251,150 |
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the deferred tax assets and liabilities are as follows (in thousands):
| December 29, 2018 | December 30, 2017 | ||||||
| Tax assets: | |||||||
| Inventory valuation | $ | 14,417 | $ | 13,029 | |||
| Accrued employee benefits costs | 15,333 | 7,092 | |||||
| Accrued sales tax audit reserve | 3,419 | 3,479 | |||||
| Rent expenses in excess of cash payments required | 25,628 | 24,728 | |||||
| Deferred compensation | 17,598 | 20,299 | |||||
| Workers’ compensation insurance | 9,900 | 9,153 | |||||
| General liability insurance | 5,410 | 4,265 | |||||
| Lease exit obligations | 2,010 | 1,829 | |||||
| Income tax credits | 5,773 | 4,206 | |||||
| Other | 9,160 | 6,997 | |||||
| 108,648 | 95,077 | ||||||
| Tax liabilities: | |||||||
| Inventory basis difference | (4,590 | ) | (4,141 | ) | |||
| Prepaid expenses | (1,912 | ) | (1,423 | ) | |||
| Depreciation | (87,417 | ) | (65,650 | ) | |||
| Amortization | (6,039 | ) | (3,818 | ) | |||
| Other | (2,083 | ) | (1,551 | ) | |||
| (102,041 | ) | (76,583 | ) | ||||
| Net deferred tax asset | $ | 6,607 | $ | 18,494 |
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the TCJA. The TCJA made broad and complex changes to the U.S. tax code including, but not limited to, a reduction of the federal income tax rate from 35% to 21% effective for tax years beginning after December 31, 2017. This change required the Company to remeasure our deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which generally is 21% for federal income tax purposes. As permitted by the SEC Staff Accounting Bulletin 118, “Income Tax Accounting Implications of the Tax Cuts and Jobs Act”, we recorded a provisional estimate of the effects of the TCJA on our existing deferred tax balances as of December 30, 2017, and recognized a provisional amount of $4.9 million, which was included as a component of income tax expense from continuing operations in fiscal 2017. We have subsequently finalized our accounting analysis based on the guidance, interpretations, and data available as of December 29, 2018. Adjustments made in the fourth quarter of fiscal 2018 upon finalization of our accounting analysis were not material to our Consolidated Financial Statements.
The Company has evaluated the need for a valuation allowance for all or a portion of the deferred tax assets. The Company believes that all of the deferred tax assets will more likely than not be realized through future earnings. The Company had state tax credit carryforwards of $5.7 million and $5.1 million as of December 29, 2018 and December 30, 2017, respectively, with varying dates of expiration between 2018 and 2030. The Company provided no valuation allowance as of December 29, 2018 and December 30, 2017 for state tax credit carryforwards, as the Company believes it is more likely than not that all of these credits will be utilized before their expiration dates.
A reconciliation of the provision for income taxes to the amounts computed at the federal statutory rate is as follows (in thousands):
| Fiscal Year | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Tax provision at statutory rate | $ | 143,511 | $ | 235,383 | $ | 240,894 | |||||
| Tax effect of: | |||||||||||
| State income taxes, net of federal tax benefits | 18,019 | 14,320 | 15,527 | ||||||||
| Section 162(m) limitation | 2,581 | 1,223 | 633 | ||||||||
| Tax credits, net of federal tax benefits | (7,140 | ) | (5,060 | ) | (7,227 | ) | |||||
| Share-based compensation programs | (4,522 | ) | (1,040 | ) | — | ||||||
| Enactment of tax legislation | — | 4,856 | — | ||||||||
| Other | (1,421 | ) | 242 | 1,323 | |||||||
| Total income tax expense | $ | 151,028 | $ | 249,924 | $ | 251,150 |
The Company and its affiliates file income tax returns in the U.S. and various state and local jurisdictions. With few exceptions, the Company is no longer subject to federal, state and local income tax examinations by tax authorities for years before 2014. Various states have completed an examination of our income tax returns for 2014 through 2016 with minimal adjustments.
The total amount of unrecognized tax positions that, if recognized, would decrease the effective tax rate, is $2.1 million at December 29, 2018. In addition, the Company recognizes current interest and penalties accrued related to these uncertain tax positions as interest expense, and the amount is not material to the Consolidated Statements of Income. The Company has considered the reasonably possible expected net change in uncertain tax positions during the next 12 months and does not expect any material changes to our liability for uncertain tax positions through December 28, 2019.
A reconciliation of the beginning and ending gross amount of unrecognized tax benefits (exclusive of interest and penalties) is as follows (in thousands):
| Fiscal Year | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Balance at beginning of year | $ | 1,993 | $ | 1,579 | $ | 2,922 | |||||
| Additions based on tax positions related to the current year | 621 | 527 | 460 | ||||||||
| Additions for tax positions of prior years | 257 | 14 | 139 | ||||||||
| Reductions for tax positions of prior years | (420 | ) | (127 | ) | (1,829 | ) | |||||
| Reductions due to audit results | — | — | (113 | ) | |||||||
| Balance at end of year | $ | 2,451 | $ | 1,993 | $ | 1,579 |
Note 12 – Retirement Benefit Plans:
The Company has a defined contribution benefit plan, the Tractor Supply Company 401(k) Retirement Savings Plan (the “401(k) Plan”), which provides retirement benefits for eligible employees. The Company matches (in cash) 100% of the employee’s elective contributions up to 3% of eligible compensation plus 50% of the employee’s elective contributions from 3% to 6% of eligible compensation. In no event shall the total Company match made on behalf of the employee exceed 4.5% of the employee’s eligible compensation. All current contributions are immediately vested. Company contributions to the 401(k) Plan were approximately $8.5 million, $7.4 million, and $6.6 million during fiscal 2018, 2017, and 2016, respectively.
The Company offers, through a deferred compensation program, the opportunity for certain qualifying employees to elect to defer a portion of their annual base salary and/or their annual incentive bonus. Under the deferred compensation program, a percentage of the participants’ salary deferral is matched by the Company, limited to a maximum annual matching contribution of $4,500. The Company’s contributions, including accrued interest, were $0.6 million, $0.5 million, and $0.6 million during fiscal 2018, 2017, and 2016, respectively.
Note 13 – Commitments and Contingencies:
Construction and Real Estate Commitments
At December 29, 2018, the Company had no material contractual commitments related to construction projects extending greater than twelve months.
Letters of Credit
At December 29, 2018, there were $33.5 million outstanding letters of credit under the 2016 Senior Credit Facility.
Litigation
The Company is involved in various litigation matters arising in the ordinary course of business. The Company believes that any estimated loss related to such matters has been adequately provided for in accrued liabilities to the extent probable and reasonably estimable. Accordingly, the Company currently expects these matters will be resolved without material adverse effect on its consolidated financial position, results of operations or cash flows.
Note 14 – Segment Reporting:
The Company has one reportable segment which is the retail sale of products that support the rural lifestyle. The following table indicates the percentage of net sales represented by each major product category during fiscal 2018, 2017, and 2016:
| Percent of Net Sales | ||||||||
| Fiscal Year | ||||||||
| Product Category: | 2018 | 2017 | 2016 | |||||
| Livestock and Pet | 47 | % | 47 | % | 46 | % | ||
| Hardware, Tools and Truck | 22 | 22 | 22 | |||||
| Seasonal, Gift and Toy Products | 19 | 19 | 19 | |||||
| Clothing and Footwear | 8 | 8 | 8 | |||||
| Agriculture | 4 | 4 | 5 | |||||
| Total | 100 | % | 100 | % | 100 | % |
Note 15 – New Accounting Pronouncements:
New Accounting Pronouncements Recently Adopted
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 amends the guidance for revenue recognition to replace numerous, industry-specific requirements and converges areas under this topic with those of the International Financial Reporting Standards. The ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,” which implemented a one-year deferral of ASU 2014-09. As a result of the deferral, the amendments in ASU 2014-09 are effective for reporting periods beginning after December 15, 2017. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” which further clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing,” which further clarifies the aspects of (a) identifying performance obligations and (b) the licensing implementation guidance. In May 2016, the FASB issued ASU 2016-12 “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients,” which provides implementation guidance in regards to (a) assessing the collectability criterion, (b) the presentation of taxes collected from customers, (c) noncash consideration, (d) contract modification at transition, (e) completed contracts at transition and (f) other technical corrections. In December 2016, the FASB issued ASU 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” which is intended to clarify the codification and to correct unintended
application of guidance pertaining to Topic 606 and other Topics amended by ASU 2014-09 to increase stakeholders’ awareness of the proposals and to expedite improvements to ASU 2014-09. The effective date and transition requirements for ASU 2016-08, ASU 2016-10, ASU 2016-12 and ASU 2016-20 are the same as the effective date and transition requirements of ASU 2014-09. Entities that transition to these standards may either retrospectively restate each prior reporting period or reflect the cumulative effect of initially applying the updates with an adjustment to retained earnings at the date of adoption. The Company adopted this guidance in the first quarter of fiscal 2018 using the modified retrospective transition method. Based on an evaluation of the standard as a whole, the Company identified customer incentives and principal versus agent considerations as the areas that were principally affected by the new revenue recognition guidance. The adoption of this guidance did not have a material impact on our Consolidated Financial Statements and related disclosures.
In May 2017, the FASB issued ASU 2017-09, “Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting.” This update provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. An entity should account for the effects of a modification unless (a) the fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified, (b) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified and (c) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The amendments in ASU 2017-09 are effective for public business entities for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted, including adoption in any interim period, for public business entities for reporting periods for which financial statements have not been issued. The amendments in ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date. The Company adopted this guidance in the first quarter of fiscal 2018. The adoption of this guidance did not have a material impact on our Consolidated Financial Statements and related disclosures.
In February 2018, the FASB issued ASU 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the TCJA. This guidance is effective for all entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The amendments in ASU 2018-02 should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the TCJA is recognized. The Company adopted this guidance in the first quarter of fiscal 2018 using a retrospective application, which resulted in the reclassification of $0.6 million from accumulated other comprehensive income to retained earnings in the Consolidated Balance Sheets, Consolidated Statements of Stockholders’ Equity, and Consolidated Statements of Comprehensive Income as of and for the fiscal year ended December 30, 2017. No other periods presented were affected by the adoption of this accounting guidance.
In March 2018, the FASB issued ASU 2018-05, “Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118.” The new guidance provides SEC Staff views on income tax accounting implications of the TCJA signed into law in December 2017. The guidance clarifies the measurement period timeframe, changes in subsequent reporting periods and reporting requirements as a result of the TCJA. The Company adopted this guidance in the first quarter of fiscal 2018. As further discussed in Note 11, the Company recorded a provisional impact of the TCJA in fiscal 2017. We have subsequently finalized our accounting analysis based on the guidance, interpretations, and data available as of December 29, 2018. Adjustments made in the fourth quarter of fiscal 2018 upon finalization of our accounting analysis were not material to our Consolidated Financial Statements.
New Accounting Pronouncements Not Yet Adopted
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” This update requires a dual approach for lessee accounting under which a lessee will account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability on its balance sheet, with differing methodology for income statement recognition. In January 2018, the FASB issued ASU 2018-01, “Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842.” This update permits an entity to elect an optional transition practical expedient to not evaluate land easements that exist or expired before the entity’s adoption of ASU 2016-02 and that were not accounted for as leases under previous lease guidance. In July 2018, ASU 2018-10, “Codification Improvements to Topic 842, Leases,” was issued to provide more detailed guidance and additional clarification for implementing ASU 2016-02. Furthermore, in July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements,” which provides an optional transition method in addition to the existing modified retrospective transition method by allowing a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. These new leasing standards are effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The Company intends to adopt this guidance in the first quarter of fiscal 2019 using the optional transition method provided by
ASU 2018-11. We have made substantial progress in executing our implementation plan. We are electing the package of practical expedients, which among other things, allows us to carry forward our prior lease classifications under ASC 840. Adoption of the standard is expected to result in the recognition of additional right-of-use assets and lease liabilities for operating leases of approximately $2.0 billion to $2.2 billion. We are evaluating the disclosure requirements and are incorporating the collection of relevant data into our processes in preparation for disclosure in fiscal 2019. The Company does not expect the adoption of this guidance to have a material impact on its Consolidated Statements of Income, Comprehensive Income, Stockholders’ Equity, or Cash Flows.
In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,” which amends and simplifies existing guidance in order to allow companies to more accurately present the economic effects of risk management activities in the financial statements. This update expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. Additionally, the amendments in ASU 2017-12 provide new guidance about income statement classification and eliminates the requirement to separately measure and report hedge ineffectiveness. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The amendments in ASU 2017-12 require that an entity with cash flow or net investment hedges existing at the date of adoption apply a cumulative-effect adjustment to eliminate the separate measurement of ineffectiveness to the opening balance of retained earnings as of the beginning of the fiscal year in which the entity adopts this guidance. The amended presentation and disclosure guidance should be adopted prospectively. The Company is currently assessing the impact that adoption of this guidance will have on its Consolidated Financial Statements and related disclosures.
In June 2018, the FASB issued ASU 2018-07, “Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its Consolidated Financial Statements and related disclosures.
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement,” which amends the disclosure requirements for fair value measurements by removing, modifying and adding certain disclosures. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its Consolidated Financial Statements and related disclosures.
In August 2018, the FASB issued ASU 2018-15, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This update clarifies the accounting treatment for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2019, with early adoption permitted. The amendments may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is currently assessing the impact that adoption of this guidance will have on its Consolidated Financial Statements and related disclosures.
In October 2018, the FASB issued ASU 2018-16, “Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes” which expands the permissible benchmark interest rates to include the Secured Overnight Financing Rate (SOFR) to be eligible as a U.S. benchmark interest rate for purposes of applying hedge accounting under Topic 815, Derivatives and Hedging. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted if an entity has previously adopted ASU 2017-12. The Company does not expect the adoption of this guidance to have a material impact on its Consolidated Financial Statements and related disclosures.
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